Business Breakdown Follow-up: Scale Economies Shared

A breakdown within a breakdown. Enjoy this micro-blog on ‘Scale Economies Shared’.

Following our Business Breakdown on Wise we thought reviewing this topic more deeply could help anyone seeking further insight into Wise’s competitive advantage - 'Scale Economies Shared'.

'Scale Economies Shared' (or SES) is interesting to us because it naturally lends itself to enduring growth businesses and long-term investment horizons.

What is 'Scale Economies Shared'?

SES, coined by Nick Sleep and Qais Zakaria of Nomad Partners, is a strategy where a company who benefits from ‘economies of scale’ shares those benefits with its customers, typically by offering lower prices, to gain long-term market share.

As Sleep suggests:

“Most companies pursue scale efficiencies, but few share them…We often ask companies what they would do with windfall profits… Almost no one replies give it back to customers - how would that go down with Wall Street?”

The knowledge that you could raise prices and generate more profits, with little to no harmful short-term effects is tempting, and causes many to falter.

Those that can resist make it very hard for others to compete against them, as by definition their competitive advantage widens as their growth continues – think Costco or Amazon (Diagram 1, below), and now Wise (Diagram 2).

What are the common traits of businesses who’ve sustained this model?

1) An ability to disengage from today’s short-termism and recognise that the most powerful SES models are the consequence of the accumulation of many small (counter-intuitive) decisions over a long period of time.

2) A zealous, steadfast and pedantic cultural pursuit of a sacred mission, that refuses to waver in its desire to return operational efficiencies to the customer. As Sol Price, founder of FedMart (which became Costco) once stated: “Increasing the retail prices and justifying it on the basis that we are still “competitive” could lead to a rude awakening as it has with so many.”

In Wise’s case, examples of these traits include:

- actively off-boarding large partners who were marking-up FX rates and not being transparent to customers;

- refusing to cross-subsidise routes or customers from more profitable parts of the business.

- the mission is at the centre of every decision they make: money without borders instant, convenient, transparent and eventually free.

What does this mean for a Wise investment thesis?

In the context of understanding Wise as an investment, we believe the market has two intriguing (but potentially misguided) views:

1. There has become a conflation between a SES model and a commodity business model. To form a view on this, investors need to ask themselves if Wise is either: deliberately competing on price, or they are operating in an industry defined by lower barriers to entry that can only compete on price.

2. Wise is inherently dependent on being a better version of a bad system – the status quo of correspondent banking. To form a view on this, investors need to have an opinion if Wise is in fact just a ‘breeder of very fast horses hoping the automobile never sputters into existence’.

Wen we form a view on these core market criticisms, Jeff Bezos’s mental model comes to mind: it is sometimes easier to solve what won’t change on a 10-year basis, rather than what will. In this case, we think we’re treading on fairly thick ice when we state:

1. Customers will want the lowest cost

2. Customers will want speed

3. Customers will want transparency

4. Customers will want the best all-round user experience

With a mission fanatically centred on these four pillars, one can take comfort from the fact that even if there is a paradigm shift to a faster, cheaper, better way of transferring money across borders – Wise will be doing their utmost to be at the forefront of that change.

Article written by James Revell , Investment Team member at TDM Growth Partners

Listen to the full Business Breakdown Episode.